Monday, July 18, 2011

Stress and State Finances

A smug feeling must have pervaded through the Square Mile of London on Friday, when none of the major English banks failed the ECB stress tests. This is however only a slither of a much longer drama being played out in both the financial markets and the media. Spanish banks lead the way with their already known banking failings, yet the Spanish state seems powerless to do anything about it. The economy is much the same as Italy - it is only a matter of time before a bail-out becomes a reality. The question is not when, but how much? Personally I hope not to see Spain go 'cap in hand', it would be disasterous to the Euro-zone. Feelings in the British press seem plainly ignorant to the contagion effect such a financial meltdown would have on UK plc, and UK banks.

Should we be worried at all by any of this? When looking at the Spanish banks, they are not universally traded, they have little or no economic power outside of Spain (http://goo.gl/IiM9A) , and it would appear that they do not hold much Greek debt. Be that is it may, it is troubling to many that Spain has allowed these same banks for years carry on without enough sovereign reserves. At time of writing, Spain has not suffered any sort of mass sell of of banking stocks and shares. Cold comfort then for nations such as Greece, Germany and France. If the Greek government defaults then there is a dangerous after-shock waiting for some of those bigger banks in Western Europe. They hold much of Greece's sovereign debt and are exposed heavily to any default.

Another issue that is troubling economists at the moment is the levels of capital reserves imposed by Basel III. At the current rate banks would need somewhere in the region of 41 Billion euros to keep their ratios above the agreed 7% margin. This is expected already by the financial markets, though a criticism levied at the ECB in their stress tests, is that their bar is too low: 5%. It remains to be seen as to how this will level out, in the meantime banks would be wise to 'stock up' on reserves hoping that the much mooted Greek default passes by with less of an impact than feared.(http://goo.gl/GQ8tj). I am no economist, I don't proport to understand the intricacies of the markets and how confidence can be shattered in an instant. However it seems plain to me that if banks don't have enough cash reserves for the proverbial rainy day, then it is madness to expect governments, who are already saddled with debt far exceeding their own incomes, to bail out banks yet again.

Gordon Brown and Barak Obama were heralded as saviours of the financial world - my view is that they simply threw money they didn't have at a problem they failed to recognize and tackle to the core. A dangerous precedent has been set by governments 'paying' off banks because 'they are too big to fail'. The current reset of this capitalist cycle is not complete - it is simply on pause.